FASB Moves to Nix “Cash Equivalents”

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Accounting standard setters have taken another step toward erasing the term “cash equivalents” from corporate financial statements. In what one board member called a “perfect opportunity” to simplify accounting standards, the Financial Accounting Standards Board approved a staff recommendation on Wednesday to eliminate the heading “cash equivalents” from balance sheets and cash-flow statements.

The FASB staff had recommended that cash-flow statements should present only flow related to cash. Items currently classified as cash equivalents would be classified in the same way as other short-term investments. The FASB staff is now assigned to work on the issue of what footnotes should appear to describe items listed under the “cash” and “short-term investment” headings and how the change in presentation might influence cash-flow statements.

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The FASB staff will report back to the seven-member board on the deliberations of International Accounting Standards Board as it decides whether to eliminate the cash equivalents heading from financial statements of foreign companies. The issue was on the agenda for IASB’s regularly scheduled meeting on Thursday. FASB and IASB are currently working on a joint project to reconcile U.S. generally accepted accounting principles with foreign accounting standards.

FASB considered the change because critics have claimed that the description of cash and cash equivalents put forth in Statement FAS No. 95, “Statement of Cash Flows,” is outdated. The 20-year-old rule loosely defines cash equivalents as liquid assets with a maturity of three months or less.

The FASB staff had been assigned by the board to vet the notion of purging the phrase “cash equivalents” from financial statements. In response, the staff pointed out that in today’s market, it’s possible to have short-term investments that are more liquid (closer to maturity) than cash equivalents. Thus, with added disclosure notes, presenting what are now cash equivalents as short-term investments on the balance sheet “will provide users with the same, if not more, liquidity information than what they receive today,” the staff wrote. Such short-term investments include auction-rate securities (ARS) and variable-rate demand notes (VRDN).

According to a PwC advisory, FAS 95 “allows only slight leeway for maturities to exceed three months,” and the legal maturity of ARSs and VRDNs are 20 to 30 years. PwC acknowledged that corporations that hold the instruments achieve liquidity by selling them into an established marketplace. However, the holder must “rely on third parties to provide current liquidity.”

Classifications based on an “arbitrary time frame” make it hard to “justify why the time frame should not be, say, two months or four months,” notes Steve Grice, a partner with accounting firm Carr, Riggs, & Ingram. “For purposes of evaluating liquidity, it seems that the FASB recognizes that the three-month benchmark . . . may not be widely relied upon since [the board] indicated the classification may be moot,” said Grice

Most financial-statement users “ignore the difference between cash and cash equivalents. They think of it as all cash,” contends Charles Mulford, an accounting professor who oversees the Financial Analysis Lab at Georgia Institute of Technology. Mulford reckons that whether cash is sitting in a checking account or a money-market account—which is currently classified as a cash equivalent—the funds are still available for withdrawal without restriction. What FASB has done is “reconcile the official word with practice,” asserts Mulford.

Several FASB members explained that the next step is to work out what types of disclosures should accompany the new cash heading. Leslie Seidman, for example, suggested using footnotes to describe the nature and maturity of cash investments that would include such information as whether the instruments are investment grade or affected by exchange-rate risk.

FASB has been working to update the FAS 95 definitions for over a year. In July, the debate about the cash and cash equivalents reached a head when the Association for Financial Professionals, a group representing corporate treasurers, called on FASB
to clarify its definition of cash.

In a strongly-worded letter to FASB, AFP noted that the lack of a clear definition allowed Big Four accounting firms to reinterpret the standard, which reportedly created confusion and required companies to modify or restate financial statements. The AFP said that the problem arose in February 2005 when PricewaterhouseCoopers changed the accounting treatment for an ARS, and then again in March 2006, when the auditor issued a document applying the same logic they used on ARS to a VRDN. Reportedly, other Big Four auditors followed PwC’s lead.